Over the past year, we have watched the Canadian dollar drop
relative to its U.S. counterpoint impacting Canadian businesses.
U.S. goods and services are now more expensive, U.S. sales make a
premium and errors when recording foreign exchange transactions can
cost you more money.
The starting point to recording foreign exchange transactions is
choosing an accounting policy. Most policies look something like
Foreign Currency Accounting Policy
The company translates monetary assets and liabilities (any item
paid for or settled in cash) into the Canadian dollar at exchange
rates prevailing on the balance sheet date. Non-monetary assets and
liabilities are translated at the historical rate in effect when
the transaction occurred. Exchange gains and losses from the
translation of monetary items are included in net income for the
year. Revenues and expenses are translated at the spot rate on the
date the transaction occurred.
Foreign Exchange Gains or Losses
When your company translates its foreign currency transactions,
such as purchases or sales, no foreign exchange gain or loss is
recorded. Foreign exchange gains and losses are caused by holding
U.S. cash or from the timing difference between when a transaction
is entered into and when it's settled.
You purchase $100,000 in vehicles from a company in the United
States worth $130,000 in Canadian and record the purchase. Then you
pay the vendor and now it costs you $135,000 due to foreign
exchange fluctuations. Your inventory is not adjusted by $5,000,
instead a foreign exchange loss is recorded.
Gains or losses represent your company's risk from foreign
exchange rate fluctuations. No timing difference – no
At Year End
Monetary assets and liabilities are usually translated twice,
but sometimes can be translated three times. The first translation
occurs when the asset or liability is created, the second time when
it is settled, and the third translation occurs at year end, as
companies are required to translate monetary assets or liabilities
using the year end spot rate.
Foreign Currency Transactions and the Income Statement
If your company has U.S. sales or purchases, you've seen an
increase in your revenues or expenses either improving or harming
your bottom line. If your U.S. sales are similar to your U.S.
expenses both the revenue and expense numbers will be larger, but
net income won't change (we call this a natural hedge).
An example of a natural hedge is a construction company working
in the United States. They are paid in U.S. dollars, but also pays
their American workers in U.S. dollars. Only companies with just
U.S. sales or U.S. purchases (not matched to each other) will see a
change in their net income from the dropping Canadian-U.S. exchange
As a public accountant our work includes assessing the impact of
accounting errors on your company's operations. We do this by
asking what effect the error will have on business decisions.
Some translation errors will have minimal impact on your
company's decisions. Under Accounting Standards for Private
Enterprises (ASPE) you are required to record marketable securities
at fair market value including translating any U.S. securities
using the U.S. spot rate on the reporting date. If you don't do
this, would it cause a poor decision? Probably not, as you can find
the fair market value of the securities on monthly investment
statements. Other errors are not so benign.
Sales and purchases
The most common error is using the wrong exchange rate, and if a
company translates a purchase or sale incorrectly, the error will
show up in the related accounts receivable or accounts payable
balance. When the account is settled it will be paid in the correct
foreign currency amount.
Any error will then be adjusted to a foreign currency gain or
loss (along with the actual gain or loss). Errors in accounts
payable or accounts receivable are self-correcting as they are
settled; however, the original sale or purchase will still be
recorded at the wrong historical amount.
A company does up a bid for construction work and sources some
of its material from its current inventory, but these inventory
items have been translated at the wrong rate. The company bids
using a 15% mark-up on costs and if $230,000 of inventory has been
incorrectly recorded at $200,000 due to an exchange translation
error the company will have eaten up its 15% mark-up.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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